Roger J Kerr says the weight of probability favours the NZ dollar retreating to the US71c to US72c range

It has been a topsy-turvy ride in the FX markets for the Kiwi dollar against the USD over this last week.

The extreme daily volatility up and down between a low of 0.7270 and a high of 0.7430 on 24 January highlights to me that the market is now really undecided whether the Kiwi can continue its steep gains since Christmas or the next move is back down.

You often see such wild daily volatility when a currency is at the end of significant uptrend or downtrend.

Certainly, those currency speculators who bought the Kiwi dollar at the 0.6900 level in December will be highly incentivised to unwind their positions by selling the Kiwi at 0.7400 and thus take profits on a five-cent appreciation over a very short space of time.

The NZD/USD rate ran into considerable previous resistance in the 0.7400’s in September 2016 and again in July 2017.

On the two previous occasions, the Kiwi reversed direction back to below 0.7000 due to lower dairy commodity prices in 2016 and the political risk environment last year.

We do not appear to have similar negative risks looming for the Kiwi dollar in early 2018 to drive the rate immediately back down to below 0.7000.

However, looking ahead over coming weeks and months the weight of probability does favour the NZD/USD retreating somewhat to the 0.7100/0.7200 area for two main reasons:-

US dollar sell-off ending

The major reason the NZD/USD rate has been above 0.7400 is the very weak US dollar in global currency markets, it has not been about NZ dollar appreciation or anything positive happening in the NZ economy.

The US dollar sell-off over recent months may be coming to an end as strong reasons to continue selling the currency from $1.2400 against the Euro are diminishing.

The Americans seems to be confused themselves as to whether they prefer a strong or weak currency value.

US Treasury Secretary, Steven Mnuchin sent the financial markets into a spin when he stated last week that the weaker US dollar is good for the US economy.

The US dollar weakened further on this report as it is highly unusual for any US Government officials to comment on their own currency’s value.

The US dollar selling stopped when Mnuchin was forced to retract his statement and confirm the normal “strong dollar” policy.

The Trump administration’s move to impose import tariffs on solar panels and washing machines coming into the US was viewed as negative for the USD as it confirms their new policy of trade protectionism.

The prospect of a retaliatory Chinese trade war with the US has increased in risk, and President Trump’s “America first” cheerleader speech at the Davos economic pow-wow would not have reduced that risk.

The Europeans will not be happy that the Euro has strengthened so rapidly to $1.2400 as it reduces their export competitiveness and lowers imported inflation at a time when they have been signalling the phasing- down of their super loose monetary policy due to rising inflation.

Similar to the Kiwi dollar market after a big run up, the speculators in the EUR/USD markets will be assessing whether it is now time to take profits on the USD sell-off from $1.1500 to $1.2400.

NZ economic trends

Whilst the general outlook for the NZ economy in 2018 remains moderately positive, there are a few concerning trends.

Business confidence/sentiment measures have declined sharply and last week manufacturing forward orders fell away alarmingly to a five year low.

Regional and small business confidence indices have also dropped.

There appears to be more to the negative business outlook than just a knee-jerk reaction to a new left-leaning Government.

Changes with the minimum wage and other workplace policies may be having more of a negative impact than first thought.

On the other side, export commodity prices are currently at high levels and the economy always does well when this is the case. Should export commodity prices start to pull back, the economic outlook does not look so good.

The much lower than expected +0.1% CPI inflation result for the December quarter last week pulled the Kiwi sharply lower.

A weaker economy and inflation tracking lower than forecast are a recipe for a lower Kiwi dollar value.

Roger J Kerr contracts to PwC in the treasury advisory area. He specialises in fixed interest securities and is a commentator on economics and markets. More commentary and useful information on fixed interest investing can be found at rogeradvice.com